The IRS issued final regulations regarding the definition of “substantial risk of forfeiture” under Code Section 83. These regulations have a particular impact on the timing of taxation of employer transfers of stock and other equity rights to employees under an equity compensation plan or otherwise. Code Section 83 generally requires that property transferred in connection with the performance of services is taxable when the property is no longer subject to a “substantial risk of forfeiture.” The final regulations state that a substantial risk of forfeiture exists (1) where the employee is required to perform future service, or (2) where there is a forfeiture condition that is related to the purpose of the transfer.
The final rules do not substantively change the definition of “substantial risk of forfeiture” from the proposed rules released in May 2012, but they clarify that (1) a substantial risk of forfeiture may be established only through a service condition or a condition related to the purpose of the transfer; (2) both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture event will be enforced must be considered in determining whether a substantial risk of forfeiture exists, and (3) transfer restrictions (e.g. lock-up periods and limited trading windows) do not create a substantial risk of forfeiture, including restrictions that carry the potential for forfeiture, disgorgement of some or all of the property, or other penalties. The regulations provide, however, that a substantial risk of forfeiture does exist as long as a transfer of property could carry liability under the insider trading restrictions under Section 16(b) of the Securities Exchange Act of 1934.